Corp Fin refuses to permit exclusion of proposal to amend proxy access bylaws under Rule 14a-8(i)(10). Who is gaming the system?

Just when we thought we had a handle on the new rules of the game for exclusion of proxy access shareholder proposals comes this new letter to H&R Block, issued on July 21. The proposal, from the prolific James McRitchie (one of the group working with John Chevedden), requested that the board amend its existing proxy access bylaw provisions as specified in the proposal. The company sought to exclude the proposal on the basis that it had already been “substantially implemented” under Rule 14a-8(i)(10). The Corp Fin staff refused to allow the company to exclude the proposal.

In 2015, faced with a proxy access proposal from McRitchie, the company had adopted a 3%/3-year proxy access bylaw with a right to nominate 20% of the board and an aggregation cap of 20 holders. Loaned securities would be counted as owned provided that they were recallable within three business days. The company bylaws also placed restrictions on the renomination of shareholder nominees who received less than 25% of the vote. McRitchie then withdrew his proposal.

The 2016 proposal from McRitchie requested that the board adopt and present for shareholder approval revisions to its proxy access bylaw as follows:

“1. The number of shareholder-nominated candidates eligible to appear in proxy materials should be one quarter of the directors then serving or two, whichever is greater.

2. Loaned securities should be counted toward the ownership threshold if the nominating shareholder or group represents that it has the legal right to recall those securities for voting purposes, will vote the securities at the annual meeting, and will hold those securities through the date of that meeting.

3. There should be no limitations on the number of shareholders that can aggregate their shares to achieve the required 3% ownership to be an “Eligible Shareholder.”

4. There should be no limitation on the renomination of shareholder nominees based on the number or percentage of votes received in any election.”

McRitchie argued that the company’s version of proxy access bylaws “contain troublesome provisions that effectively make them unusable” by anyone other than the biggest shareholders. Further, the limitation on the number of proxy-access directors could preclude these directors from serving on multiple committees. In addition, requiring recall of loaned shares within three business days could conflict with existing contracts; the ability to recall the shares in time to vote them at the annual meeting should be sufficient. The proponent also argued that the 20-person cap on aggregation could make it extremely difficult to satisfy the 3% threshold, even for the 20 largest public pension funds shareholders. In addition, the SEC did not impose any aggregation cap in its now-vacated proxy access rule. Finally, “renomination limitations do not facilitate the shareholders’ traditional state law rights and add unnecessary complexity.”

The company sought to exclude the proposal on the basis that the proposal had already been substantially implemented. The company contended that the staff had previously allowed exclusion of proposals as substantially implemented where the company had adopted a bylaw with the same percentage and duration of ownership thresholds “called for by the proposal, even though the company’s bylaw included certain procedural limitations or restrictions that were inconsistent with or not contemplated by the proposal.” Instead, the staff prohibited exclusion only where the ownership threshold percentage in the bylaw (5%) differed from the proposal (3%). (See this PubCo post.) In granting relief in those instances, the company maintained, the staff noted the companies’ representations that the proxy access bylaws that had been adopted addressed the proposals’ essential objective. Notably, the staff concurred that the proposals had been substantially implemented even where the proposals explicitly prohibited caps on aggregation and other restrictions not applicable to other nominees. In this case, the company argued, the essential objective of both of the shareholder proposals from this proponent was that the company permit “a meaningful and usable proxy access right,” and that essential objective was satisfied by the company’s bylaws.

In response, McRitchie argued that the SEC’s recent line of no-action letters allowing proxy access proposals to be excluded under Rule 14a-8(i)(10) represented an “about-face.” As the author of the template for those excluded proposals, he argued that the “essential purpose was not to obtain watered-down versions of proxy access” from prior practice. Rather, his template for proxy access was designed to “closely align with the essential elements defined by the SEC’s vacated Rule 14a-11 and best practices as outlined by the Council of Institutional Investors….” For 2015, he observed, he had submitted more generic proposals, “describing little more in the way of specifics than that shareholders must hold 3% of the company’s common stock for at least three years. The primary objective last year of many shareholder advocates was to begin a tidal wave of proxy access adoptions, even flawed adoptions, to get the process rolling…. After we knew we had significant momentum, we tried to get back to the provisions of the vacated Rule 14a-11 when negotiating with companies.”

However, the proponent contended, after the staff issued a no-action position to GE (see this PubCo post), the staff dropped a “bomb” in mid-February, issuing a slew of no-action positions (see this PubCo post) that “appear to have found that the only essential provisions to initial proxy access bylaws are 3% of shares held for 3 years. Contrary to prior no-action opinions, Staff ignored the fact that shareholder proposals specified various other terms: 25% of the board, no group limitations, etc….Now Staff is apparently ‘protecting’ shareholders from having to compare bylaws adopted by boards of directors, in response to shareholder proposals, with the terms requested by the shareholder…. Would that task be too confusing for shareholders? Staff declared ‘substantial implementation’ of proxy access even where dramatic differences occur between what is specifically requested and what has been granted. This appears to be the same ‘gaming the system’ that Chair White warned against last year” in connection with the staff’s revised position under Rule 14a-8(i)(9) (see this PubCo post and this PubCo post). Addressing the various specific elements of his new proposal, the proponent requested instead that the staff distinguish this proposal, which requested revision of existing bylaws, from his prior proposal initially requesting the adoption of proxy access. This position, he contended, would allow the staff to avoid repudiating the long line of no-action letters permitting exclusion of proxy access bylaws under Rule 14a-8(i)(10).

The company responded that the extensive list of no-action letters “completely support the conclusion that the Company’s Bylaws already substantially implement the Proposal. [The proponent’s] real objection is with the policy underlying the no-action letters we cited rather than their proper application in addressing the four points of factual difference between the Proposal and H&R Block’s Bylaws.” In addition, the company maintained that the distinction between an initial proposal and a proposal to revise existing bylaws was “predicated on a distinction without any substantive difference and would elevate mere form over the reality that these four factual distinctions are not sufficient to conclude that the essential objectives of the Proposal have not been implemented.”

The staff apparently accepted McRitchie’s arguments, responding that it was unable to conclude that the company had “met its burden of establishing that it may exclude the proposal under rule 14a-8(i)(10). Based on the information presented, we are unable to conclude that H&R Block’s proxy access bylaw compares favorably with the guidelines of the proposal. Accordingly, we do not believe that H&R Block may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(10).”

Arguably, depending on your point of view, the practical effect of the staff’s new position may be to repudiate the prior line of 14a-8(i)(10) no-action letters issued commencing in February, even though it is not technically doing so. That is, companies looking to adopt proxy access bylaws that might previously have felt free to conform the terms of their bylaws to those in the favorable 14a-8(i)(10) no-action letters might now hesitate to do that — especially if they want to avoid the risk of another proposal — without first at least considering the terms of amendment in the H&R Block proposal. Whether the staff’s position will be repeated or could possibly be anomalous remains to be seen. In any event, given the proponent involved, companies that adopted versions of proxy access that McRitchie et al would view as “proxy access lite” may well be seeing new proposals for revisions to proxy access bylaws.

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